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Some Alaska air taxis may owe IRS more than $1 million in taxes

Some of Alaska's air taxi services are up in arms over what they call unfair audits that have revealed hundreds of thousands of dollars -- and occasionally more than $1 million -- in back taxes owed to the Internal Revenue Service. It's prompted a letter from Sen. Mark Begich, D-Alaska, to U.S. Treasury Secretary Tim Geithner asking for an explanation of the audits' findings -- and what operators say are threats of further audits if they challenge those findings.

At the heart of the issue is vague language in the tax code that air taxi operators say is being interpreted in new ways by the IRS, leaving them exposed to per-passenger taxes that they are in no position to retroactively collect.

These per-passenger taxes are known as excise taxes, which the customer pays in order to offset the cost to the company. It's essentially a pass-through: the company makes no money off of the charge, but is then able to pay those fees to the government when tax time rolls around. Such taxes aren't uncommon: Cigarettes, alcohol, and fuel all have excise taxes built into the cost.

In Alaska, any passenger traveling on a qualified commercial flight would pay three excise taxes on their ticket or seat: a $3.70 tax for any "flight segment" (one takeoff and one landing), an $8.40 tax for flights beginning or ending in Alaska or Hawaii, and a 7.5 percent tax on the cost of a ticket.

Some Alaska air taxi operators say they should be exempt from these excise taxes because federal tax code excludes seaplanes and some sightseeing flights. Also exempt are aircraft weighing less than 6,000 pounds -- a pretty easy requirement for most Alaska bush planes to fulfill -- and traveling on "nonestablished lines."

And that's where the trouble begins.

The IRS defines an "established line" as flights "operated with some degree of regularity between definite points. It does not necessarily mean that strict regularity of schedule is maintained; that the full run is always made; that a particular route is followed … The term implies that the person rendering the service maintains and exercises control over the direction, route, time, number of passengers carried, etc."

By that definition, nearly any flight can be counted as operating on an established line. The Federal Aviation Administration sees an air taxi operator who owns a single aircraft and specializes in dropping hunters in the Alaska wilderness as an "on-demand" air carrier: that pilot flies where he's needed, when he's needed. While that may sometimes entail visiting the same place twice in the space of a week, or a few times over the course of a year, does that constitute an "established line?"

That vague language is leading air taxi operators who say they try to follow the letter of the law to be slapped with big tabs for back taxes.

Different interpretations

In June, Begich wrote to Geithner asking for an explanation of the IRS's recent actions. Begich says in the letter that IRS agents have taken an "erroneous position" on which exemptions apply to air taxi operators, noting the burden placed on small operations in paying these back taxes with no way to recoup costs from the passengers.

According to Joy Journeay, Executive Director of the 150-member Alaska Air Carriers Association, one two-plane operation was recently audited to the tune of $250,000. A statement from the AACA noted another carrier had been fined $1.8 million. She said she knew of at least one operator who had to take out a substantial loan to pay back the errant taxes.

Journeay said that the interpretation of the law has changed, leading to the sudden back taxes in recent audits.

"The nebulous, ambiguous language is the problem with the IRS codes," she said. "For 49 years, they've said charters were exempt, and now they're saying they're not."

A letter from the AACA to the commissioner of the IRS asking for a measureable definition of "some degree of regularity" got a response back from Holly McCann, chief of the IRS excise tax program.

That response, which the AACA dubbed a "non-answer," recited back the reasons that a flight might be exempt, plus an additional statement that a sightseeing flight operating on an established line would also be subject to excise taxes.

"Because the way a provider applies the tax law depends on specific facts and circumstances, we cannot provide a more specific response," McCann wrote.

Two separate inquiries to the IRS referred Alaska Dispatch back to the tax code in question, but provided no more solid interpretation of the language.

'Completely inappropriate'

Perhaps more troubling, though, are allegations that the IRS is threatening air taxi operators who owe back taxes based on a three-year audit with further audits -- reaching back up to seven years -- if they opt to challenge the findings.

Begich alludes to this in his letter to Geithner:

My greatest concern involves reports of IRS auditors threatening to make audits and penalties 'more painful' for businesses who challenge the imposition of these excise taxes based on what they believe is the misapplication of the Internal Revenue Code by IRS auditors. This type of intimidation tactic is completely inappropriate for small businesses seeking to understand and comply with a complex and at times unclear tax system.

Journeay said that she's had reports from several locations of carriers being threatened, from operators based at Anchorage's Merrill Field and Lake Hood, to carriers in Juneau and Sitka.

The problem isn't limited to Alaska, either, she said. The National Air Transportation Association will hold a web seminar in July to help air carriers navigate the IRS audit process. She also said that she'd spoken with a lawyer from Nevada who was representing a client facing a similar threat in that state.

"These aren’t guys talking about this over a beer," Journeay said. "They don’t run in the same circles."

She expressed concern about the burden placed on small carriers faced with an audit loaded with sudden back taxes.

"If you have a business with employees, do you have the pockets to drive on a court case for three to four years? Probably not," she said.

An IRS spokesman, in an email, declined to say whether the IRS was making such threats, or if the agency was even looking into the allegations.

"…because of the disclosure and privacy laws, the IRS declines to comment further for your story. Disclosure and privacy laws and regulations do not permit or authorize the IRS to comment on the tax matters of any taxpayer. It would also be inappropriate for the IRS to comment on any hypothetical or actual examples or suppositions regarding tax issues in a news story involving a specific taxpayer, group of taxpayers or industry."

Trying to comply

This isn't the first time the excise tax issue has come up. According to Bob Stanford, owner of Island Air on the Alaska island of Kodiak, he went through the process back in the mid-1990s. At that point, Island Air was more than a decade old.

Stanford said that their audit was the result of the same "established line" clause that's proving problematic for pilots today. But Stanford said that tax law was even more difficult to navigate then.

"We learned the hard way," Stanford said. "Back in the mid-90s, you couldn't just Google it."

The details were elusive since it had been nearly two decades since the audit, but Stanford said that the back taxes stretched for several years, and came as a complete surprise.

"It's a simple, honest mistake," Stanford said. He added that several operators in the Gulf of Alaska region were cited that year for uncollected excise taxes. At least one other operator near Wrangell-St. Elias National Park that Alaska Dispatch spoke with had been through a similar process.

As Begich alluded in his letter, air taxi operators are seemingly trying to comply but finding it difficult when the IRS interpretation and the FAA designation are in conflict, leading to confusion from those trying to navigate the complicated aviation tax law.

Journeay agreed. After all, operators who aren't collecting per-passenger excise taxes are instead paying excise taxes on fuel, so any benefits of not collecting those fees are limited.

"What is most frustrating to us is the guys who are being audited and getting these fines so far, they're the most conscientious collectors of taxes," Journeay said. "They're not trying to skate and get away with anything."

Stanford said that the process had left a "bitter taste" in his mouth, and he had been frustrated by the lack of oversight.

"It was abusive," he said. "It was a very abusive system. Because the knowledge is not easily disseminated, even when you go look for it, most people won't know about it. And that's why it's an abusive tax."